IMF: In some CESEE EU countries, current solid growth may be difficult to sustain

According to the recently published IMF report Central, Eastern, and Southeastern Europe: Effective Government for Stronger Growth, with profit margins near 2009 lows in some and falling appreciably in other CESEE EU countries, the current solid growth may be difficult to sustain. In Hungary, the Slovak Republic, and the Baltics, corporate margins are already close to the lows seen during the 2009 crisis, when businesses started to reduce labor costs through layoffs and wage cuts. And, in the Czech Republic, Poland, and Romania, margins have deteriorated appreciably since end-2015. While there is uncertainty about how the decline in margins will play out, without a rebound in productivity, which takes time, it may be difficult to achieve durable growth. In countries where margins are at very low levels and firms cannot pass through increased labor costs to goods prices, for example, because of emerging signs of external competitiveness pressures in some cases, growth will likely moderate. In countries where corporate profit margins have deteriorated, but corporates could absorb higher labor costs or pass it onto prices of final goods (for example, CEE, Romania), solid growth may continue in the near term, but it may be hard to sustain over the medium term.

Also, the report says. fiscal policy is expected to be neutral or expansionary in many economies in the region, while structural fiscal deficits remain large. On the back of largely closed output gaps outside the CIS (Commonwealth of Independent States), fiscal policy is pro cyclical in several economies, with structural fiscal deficits estimated to deteriorate in 2016–17 relative to 2015 (for example, the Czech Republic, Hungary, Poland, Romania, Turkey). The deterioration of structural fiscal balances in these economies reflects a combination of spending slippages and tax cuts.

After several years of contraction since the global financial crisis, credit is finally picking up in many CESEE countries outside the CIS and Turkey. In the Czech Republic, Poland, and the Slovak Republic, and more recently, Lithuania, credit growth has increased notably since 2014. In countries where banks have been more profitable (for example, the Czech Republic and the Slovak Republic), credit growth has been stronger than in countries with weaker bank profitability.

According to the report, most CESEE countries have improved the efficiency of their public investment since 2006. While the already strong performers—the Baltic states and the Czech Republic—have remained close to the efficiency frontier throughout 2006–13, a number of countries—such as Albania, Croatia, Macedonia, Poland, and Turkey—have made significant progress.

Also, in all CESEE countries, the shadow economy has been shrinking since 2005. Particularly in Latvia, Lithuania, and Romania, the decline in the shadow economy was the largest, ranging from 4 to 6 percentage points of GDP during 2005–15. For example, in Latvia the authorities undertook comprehensive and large-scale efforts to reduce the size of the shadow economy between 2010 and 2013, while in Lithuania, illegal workers’ inspections have doubled since 2011. The Czech and Slovak Republics also managed to reduce the shadow economy considerably from already low levels during the same period. In the Czech Republic, measures to tackle the shadow economy focused on reducing bureaucracy and making the tax submission process more user-friendly, while in the Slovak Republic, the government aimed to limit the use of cash in the economy and streamline the tax system. Thus, improving tax administration efficiency and reducing regulatory burden on firms in CESEE could help to further reduce the shadow economy. This would in turn increase the tax base, further improve economic structure and mitigate the negative externalities of the shadow economy on the formal sector, the report suggests.

The IMF expects the Czech total external debt to GDP to reach 68.1% and 67.7% in 2016 and 2017, respectively. Public debt should amount to 39.8% and 38.8% in 2016 and 2017, respectively. The report does not take into account Brexit, as its impact is unclear.

Also, if the quality of public investment management and tax administration is raised to the level of countries with best practice, CESEE countries could generate between 2 and 4 percent of GDP of additional resources over the medium term, the IMF says.

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